Co-produced with Trapping Value and PendragonY
We have now had many months for the market to recover from the correction it experienced at the end of 2018. Still, opportunities exist. One such stock is America First Multifamily Investors, L.P. (ATAX).
ATAX holds mortgage revenue bonds and generates income exempt from U.S. federal taxes. This is a battle-tested company that continued to pay good dividends, even during the financial crisis of 2007-2008. ATAX closed recently at $7.15 and pays 50 cents per year distribution for a 7% yield. Since the dividend is tax-exempt from US federal income taxes this is the equivalent of a dividend of ~60 cents or a taxable equivalent yield of 8.45%. With a compelling business model, $1 billion in assets and growing ATAX is growing "cash available for distribution" (CAD), which is the earnings metric used by the company to assess profitability and the dividend coverage.
ATAX has been a solid performer. CAD for the year, 2018 was ~21% higher than 2017 and for the last 12 months, CAD has exceeded the 50 cents dividend by 23 cents or provided 1.46 times dividend coverage.
Strong Business Model
ATAX's primary business is holding Mortgage Revenue Bonds (MRBs). These are tax-advantaged mortgage debt instruments secured by multifamily residential projects. Some of these apartment buildings are oriented to seniors or college students. Although MRBs are called "bonds", these securities more closely resemble mortgages on the individual properties. The holder of the bond (ATAX) has the right to foreclose in the event of a default. The mortgages are generally long term with monthly repayment of principal. ATAX carries some 79 of these instruments on its consolidated balance sheet. Most of the bonds are in face amounts of between $5 million and $15 million. ATAX has a widely diversified portfolio of these bonds so that its exposure to a default on any single property is limited.
ATAX considers MRBs to be its core business. ATAX owns some of these MRBs directly, while others are held in securitization facilities initiated by ATAX, and unconsolidated facilities holding MRBs.
Source: Atax Q2 Supplemental
To qualify for the exemption from US federal income taxes, the buildings securing the MRB must rent a certain percentage of units to tenants whose incomes fall below a certain percentage of the regional median net income. Once qualified, the income from the bonds is tax-exempt which flows through to the limited partners’ distributions as well.
The bonds typically are set at fixed interest rates around 6% although there are some second mortgages set at double-digit rates. An important feature to note is that the MRBs typically carry a "kicker" provision allowing for supplemental interest to be generated based on the performance and the appreciation of the property secured.
The regular repayment of the principal also helps reduce risk because the debt to fair value of the mortgaged apartment buildings is declining in a predictable way due to principal pay downs.
ATAX can also take over the property if there is a default (assuming it is the first mortgage), which further limits default risks on the bonds.
Another important point to note is that most of these bonds have relatively long maturities with most maturing in the years 2030, 2040, and 2050, so the company has already secured some nice cash flows for several years to come.
How was ATAX impacted by the Subprime Lending Crisis of 2007-2008?
Since ATAX neither owns single-family mortgages nor has made subprime loans, the crisis had very little impact on its operations. While the ATAX share price did take a hit like the vast majority of the stock markets in 2007-2008, the stock price quickly recovered. More important, the dividends remained relatively stable, there was a slight reduction of 7%, but they kept coming. ATAX has been a steady income payer even in the most difficult of times. This is a battle-tested company with a proven business model that continued to generate solid income during very challenging times for mortgage holders.
Low Borrowing Cost
Another advantage of ATAX is its low financing cost. It is able to structure some of its borrowings with Freddie Mac-assisted financing at low rates. It has held some of its MRBs in special facilities which in turn receive preferential financing. Its current borrowing is at between 3.82% and 4.52% fixed and below 4% variable. It has been increasing the fixed percentage of its borrowings. The fixed percentage was at 57% at the end of Q3 2018, up from 32% in 2015 and is now around 70%.
ATAX has reasonable leverage considering the relatively low risk associated with its asset base. At the end of June 2019, its leverage ratio was 61%, which is actually low considering that ATAX is in many ways analogous to a mortgage REIT. The leverage ratio varies quarter to quarter but stays in the low 60% range.
Source: Atax Q2 Supplemental
ATAX risk is further reduced because multi-family housing has been one of the better real estate performers.
Preferred Stock
ATAX has also issued a preferred stock at a preference value of $10.00 per share. The preferred pays a 3.0% distribution on this liquidation value. Once again, ATAX's tax preference permits it to raise debt and capital at very low rates. This preferred stock does not appear to be publicly traded.
Outstanding Recent Performance
In Q2 the book value (per the earnings conference call) was $5.30, up from $5.13 last quarter and from $5.03 at the start of the year. Currently, the share price is trading at around the long-term average premium to book value. So at the recent price of $7.10 is still a good value. The stock price has recovered from its drop during the 2nd half of last year and is again trending upwards on its longer-term path.
ATAX’s cash flow performance has been excellent as well. Over the last 12 months, it has generated CAD of 73 cents per partnership unit, well in excess of its distribution. Multifamily housing is the sweet spot in real estate right now. In many parts of the country, housing is tight. There is pent-up demand in the form of millennials still living with mom and dad and wanting to branch out on their own. Many of the issues facing other real estate investments (competition from online retail, excess capacity, obsolescence) do not really apply to multifamily housing.
The company’s income does move with interest rates and the recent 25-basis-point cut will improve its performance.
Impact of Interest Rate Changes on NII Source: 10-Q
Given that rates are likely to fall in the future, it is good to see that NII increases with falling rates, provided that all interest rates react as they have in the past. This is good for the company and improves the distribution coverage. As can be seen above though, the company’s income is vulnerable to rapidly rising rates. This however, is not our base case for the foreseeable future.
Solid Distribution Coverage
ATAX uses "cash available for distributions" (or CAD) to cover its distributions because GAAP EPS contains some non-cash charges that do not accurately reflect the cash ATAX has available to pay dividends. ATAX has a trailing-twelve-month CAD of 73 cents per unit, providing coverage of its current distribution at the level of 146%. As noted above, ATAX has been increasing its CAD and its properties are performing well. Such that CAD for 2018 was 21% higher than in 2017.
Management appears committed to maintaining the distribution at the 50 cents per unit level. Given that CAD significantly exceeds the dividend payment there appears to be no reason that management should have any difficulty in doing so.
Tax-Free Income
On the tax issue, we must start by disclaiming any expertise and urging readers to consult your own accountant. However, this is our understanding of how ATAX's income is received tax-free by investors. Since ATAX is a limited partnership, investors receive K-1 tax forms that provide necessary information about federal and state tax liability. The quarterly distributions are not taxable. Our understanding is as follows:
- The distributions (or dividends) will reduce the cost basis of your investment in ATAX. This is typical of publicly traded partnerships.
- This is offset by your share of the tax-exempt interest income earned by ATAX which is available on the Schedule K-1. This tax-exempt interest income increases back your tax basis, and by doing so, you will be offsetting the reduction in your cost basis, and your cost basis should remain the same and, therefore, will not generate any tax liability.
- Some of ATAX's income may also be exempt from state income tax in certain states depending on the location of the assets securing its bonds.
Great Valuation And Recommendation
For an investor paying 25% marginal federal tax rates it would take an ordinary income dividend of 60 cents to produce the 45 cents of after-tax income that ATAX produces even in a state in which all of the ATAX income is subject to the state income tax. Using this after-tax equivalent method, ATAX could be viewed as having an 8.45% taxable equivalent yield because that's the level of pretax dividends that would be necessary to generate an equivalent post-tax yield. If you pay a higher marginal rate your benefits are even greater. ATAX thus provides investors with an incredibly attractive risk-adjusted after-tax return.
Conclusion
ATAX is a rock-solid financial company with a solid track record tested under the harsh conditions of the financial crisis. The financial crisis, despite hitting many financial-based businesses hard, produced little disruption for ATAX and only a small impact on its distribution. Given the stability of its assets and the strength of its business model, we have previously estimated that ATAX should trade at a level of at least 15 times CAD. Being more conservative and using only a multiple of 11.5 with the trailing-12-month CAD of 73 cents, this would suggest a price of $8.40 or 28% above the current unit price. At that level, the yield would be 5.9%, which is reasonable for a tax-exempt equity yield. For income investors, ATAX is a Strong Buy for its tax-advantaged yield of 7% and the potential for long-term capital gains.
A note about diversification: To achieve an overall yield of 9%-10% and optimal level of diversification, we recommend a maximum allocation of 2-3% of the portfolio to individual high-yield stocks like ATAX and a maximum of 5% allocation to high-yield exchange-traded products (such as ETFs, ETNs, and CEFs). For investors who depend on the income, diversification usually results in more stable dividends, mitigates downside risk, and reduces the overall volatility of your portfolio. Given the 16+% gain in ATAX since we last recommended it, investors should check to make sure their position has not exceeded allocation limits.
Thanks for reading! If you liked this article, please scroll up and click "Follow" next to my name to receive our future updates.
High Dividend Opportunities, The #1 Service for Income Investors and Retirees
We are the largest community of income investors and retirees with over 3000 members. Our aim is to generate high immediate income. We recently launched our all-Preferred Stock & Bond portfolio for safe high-yields ahead of a weaker economy and market volatility.
Join us today and get instant access to our model portfolio targeting 9-10% yield, our preferred stock portfolio, our bond portfolio, and income tracking tools. You also get access to our report entitled "Our Favorite Picks for 2019"
